Corporate earnings are the lifeblood of the economy. Every company must be profitable to stay in business, pay dividends, and invest in future growth. That’s why the public hears so much about record earnings. Unfortunately, those rosy numbers may be boosted by accounting quirks that don’t reflect long-term value creation. For example, companies might use a rule that requires them to list assets at the price they originally paid for them rather than their current market value. This can hide the fact that a company is burning through capital to maintain its infrastructure. It can also obscure how much inflation is eating into operating costs and replacement costs. This is not fraud; it’s just a flaw in the rules that investors must be aware of.
Corporate profits are based on three main factors: revenue, expenses, and net income. Revenue is the total amount of money a company collects from its customers during a reporting period for services rendered or products sold. Then, all of a company’s expenses are deducted from that revenue to arrive at gross profit. Lastly, any money left over from that calculation is called net income.
Investors and traders analyze these figures to gauge a company’s financial health. Some focus on metrics that can provide insight into long-term performance, like revenue trends and earnings per share (EPS). Others look at the details of a company’s forward guidance to gauge expectations and shape immediate market sentiment. In the end, all of these factors combine to influence how much a company’s stock is worth on the market.